Interest Rates Hit a Milestone for First Time Since 2008

Ivan Schwartz
June 22, 2017

Most analysts believe the Fed will raise the federal funds rate — what banks charge each other for short-term loans — for the second time this year.

The dollar rose to its highest in more than two weeks as solid readings on the US economy helped strengthen the case for the Fed to continue tightening.

U.S. rates are now at their highest level in nine years.

Sterling climbed out of the red after a higher than expected number of Bank of England Monetary Policy Committee (MPC) members voted to raise interest rates on Thursday.

The Fed also said in its statement that it expects to begin shrinking its balance sheet starting sometime this year.

The Fed has now raised rates four times as part of a normalization of monetary policy that began in December 2015. That effort resulted in a five-fold increase in its portfolio to $4.5 trillion.

The markets didn't exactly jump at the news either. The CME FedWatch Tool indicates a market estimate of a rate hike in March. It intends to start the draw-down with small monthly cuts of $6 billion of Treasury debt and $4 billion of mortgage-backed securities, and gradually increase them thereafter. Those figures would rise in increments over a year until they reached $30 billion a month in Treasurys and $20 billion in mortgage bonds.

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Also yesterday, Fed Chair Janet Yellen declined to say whether she would stay on for a second term if asked by President Trump. "When taking into account the fundamentals and recent economic indicators, a massive capital flight won't be taking place", she said.

However, Anna Stupnytska, global economist at Fidelity International, said "emerging headwinds" in the U.S. economy meant a second hike would be unlikely this year.

The market is expecting one more rate hike by the Fed in the current fiscal year.

The rate forecast, based on individual projections from each member, envisions three more rate hikes in 2018 and three more in 2019. The Fed is now targeting short-term rates of between 1% and 1.25%. "The economic growth is not sufficient enough to warrant an interest rate increase".

Experts said that the State Bank of Viet Nam's policies on exchange rates helped the market avoid external shocks, adding that the Fed rate hikes would not have significant impacts on VND/USD exchange rates. Yellen also indicated that a third rate hike is likely for this year during the quarterly press conference.

"The Fed is going to have to wake up". Inflation was expected to be at 1.7 percent by the end of this year, down from the 1.9 percent previously forecast. Unemployment dipped to 4.3 percent in May, a 16-year low.

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